Why Bank Of America Is Overvalued

The broader market and the share price of Bank of America (NYSE:BAC) continues to trend higher as the Fed and ECB add monetary stimulus to the financial system. The ADP non-farm employment change report signaled solid jobs growth over the past 15 months. Also, the unemployment claims number has been coming in below 400 thousand.

Point being, general business conditions remain good. Next we'll cover Bank of America specifically.

Interest Income

Gross interest income continued to decline in 2012 compared to 2011. The decline was 13 percent; that compared with a 12 percent decline in 2011 relative to 2010.

Between 2003 and 2012, gross interest income increased at an annual nominal compound rate of 7 percent. However, gross interest income peaked in 2007 and declined every year since. The pace of decline increased.

Net interest income declined 9 percent in 2012 compared to 2011. Between 2003 and 2011, net interest income increased at a nominal annual compound rate of 8 percent. That said, net interest income peaked in 2010, which was after gross interest income peaked.

The net interest income-gross interest income margin increased from 39 percent in 2007 to 71 percent in 2012.

Total Non-Interest Income and Net Income Applicable to Common Shareholders

Total non-interest income declined 13 percent in 2012 compared to 2011. Total non-interest income declined every year since 2009. That said, the pace of decline slowed from 19 percent.

Net income applicable to common shareholders increased in 2012 compared to 2011. Common shareholders' net income turned positive in 2011 following losses in 2009 and 2010.

The net income-net interest income plus total non-interest income margin declined to 3 percent from over 20 percent prior to 2008.

Full-Year 2013 Projections

If gross interest income declines 15 percent compared to 2012, gross interest income would be $48.79B. If gross interest income increases 5 percent compared to 2012, gross interest income would be $60.27B.

The low end of the net interest income range applying a 65 percent margin would be $31.71B and the high end applying a 72 percent margin would be $43.39B.

Total non-interest income would be about $36.28B if it declines 15 percent and about $44.81B if it increases 5 percent.

I'm forecasting a net profit margin between 2 percent and 15 percent in 2013. The low end of my forecast for net income applicable to common shareholders is $1.36B and the high end is $13.23B.

First Quarter 2013 Projections

I'm forecasting gross interest income in the first quarter of between $13.5B and $14.5B.

Assuming a 65-72 percent net interest income-gross interest income margin, net interest income should be between $8.78B and $10.44B.

Total non-interest income should be between $8B and $9B.

Applying a 5-15 percent net income applicable to common shareholders-net interest income plus non-interest income margin, I'm forecasting net income applicable to common shareholders in the first quarter between $838.75B and $2.92B.

Also, common equity shares outstanding should increase to 10.8B from roughly 10.7B.

Valuation

Using a share price of $12.15, average basic shares outstanding of 10.746B, and gross interest income of $57.4B, I calculate a common equity share price-gross interest income ratio of 2.27.

Using my forecast for 2013 gross interest income, average basic shares outstanding of 10.961B, and the current share price, I forecast forward price-gross interest income between 2.73 and 2.21.

Given my forecast for gross interest income, there isn't a tremendous amount of upside potential for common equity shares of Bank of America.

Using the same share price, average basic shares outstanding of 10.746B, and net income applicable to common shareholders of $2.76B, I calculate a price-net income ratio of 47.31.

Using my forecast for 2013 net income applicable to common shareholders, average basic shares outstanding of 10.961B, and the current share price, I forecast a forward price-net income ratio between 97.92 and 10.07.

Thus, unless earnings are at the higher end of my range, Bank of America is probably overvalued on a forward price-earnings basis.

Based on the multiplier model valuations, Bank of America would make a good short sale candidate . Also, long equity investors should consider reducing long equity exposure.

Readers should note that I didn't discuss the adjustments made to interest income and net income, but adjustments were made to arrive at more accurate forecasts. Honestly, this article is lengthy without adding that section.

Risk & Return Profile

Using the monthly closing prices from January, 2000, to January, 2013, the nominal arithmetic average monthly return was 0.7 percent. The median monthly return was 0.4 percent. The time-series geometric mean return or compound growth rate was -0.2 percent. The nominal geometric mean monthly return on a bond equivalent basis was -2.4 percent.

We'll make a statistical inference about the population geometric mean nominal monthly return. The population geometric mean nominal monthly return at 95 percent confidence, assuming a standard normal distribution, was between 1.8 percent and -2.2 percent.

The standard deviation of monthly returns was 13.1 percent. Shares of Bank of America returned between -60 percent and -50 percent once. Between -40 percent and -30 percent three times and between 70 and 80 percent once. Forty-three percent of the nominal monthly returns were negative.

Readers should note that the selected sample contains two bull markets and two bear markets. Further, the sample contains both high interest rate and low interest rate environments.

Technical Analysis

Click to enlarge(Click to enlarge)

The common equity share price of Bank of America continues to make higher highs and higher lows. However, momentum indicators formed a negative divergence with the share price. Further, the share price remains above the rising 50-day and 200-day simple moving averages: the share price of Bank of America is in a primary term and intermediate term up-trend.

From a timing perspective, this intermediate term up-trend has lasted about four months. Typically, intermediate term trends last for one to nine months.

Further, the share price is testing resistance at the $12.10 zone after going through a consolidation phase.

That said, the common equity share price of Bank of America remains in a secular bear market. The share price just rose above the declining 200-week simple moving average.

Also, the border market remains in a Dow theory bull market.

Financial firms have been outperforming technology firms and energy firms. During this intermediate term up-trend financials, including Bank of America, were leaders.

Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.